Applying IFRS. Accounting by holders of crypto-assets. August 2018

Transcription

1 Applying IFRS Accounting by holders of crypto-assets August 2018

2 Contents 1. Introduction 3 2. Overview of crypto-asset classification 3 3. Classification and measurement Cash and cash equivalents Financial instruments Inventory Prepayments Intangible assets Own accounting policy 19 4 Presentation and disclosure Cash and cash equivalents Financial instruments Inventory Prepayments Intangible assets Additional general disclosures 21 5 Selected standard setter activity 22 Accounting by holders of crypto-assets August

3 What you need to know Crypto-assets have diverse terms and conditions. The purpose for holding crypto-assets also differs among the entities, and even among business models within the same entities, that hold them. Hence, the accounting treatment will depend on the particular facts and circumstances and, hence, the relevant analysis could be complex: In order to be considered cash, a crypto-asset would need to be generally accepted as a medium of exchange that is supported by government and recognised as legal tender in the respective jurisdiction, and considered a suitable basis on which a holder could measure and recognise all transactions in its financial statements. Some contractual crypto-assets could meet the definition of a financial asset if: they entitle the holder to cash, another financial instrument, or the right to trade financial instruments under favourable terms; or they are, in effect, electronic share certificates that entitle the holder to the net assets of a particular entity. Some contracts to trade crypto-assets are accounted for as derivatives, if the contract can be settled net or if the underlying crypto-asset is readily convertible to cash, despite the crypto-asset itself not being a financial instrument, provided that certain criteria are met. Many crypto-assets would meet the relatively wide definition of an intangible asset. However, not all crypto-assets that meet the definition of an intangible asset are within the scope of IAS 38 Intangible Assets, as the standard is clear that it does not apply to items that are in the scope of another standard. For example, some entities could hold crypto-assets for sale in the ordinary course of business and, as such, would be able to recognise these as inventory. Commodity broker-traders, who acquire and sell crypto-assets principally to generate profit from fluctuations in price or broker-traders' margin, also have the option of measuring their crypto-asset inventory at fair value less costs to sell. The holder of crypto-assets will need to consider the general disclosures required by IAS 1 Presentation of Financial Statements when compliance with the specific requirements of the relevant IFRS is insufficient to enable users of financial statements to understand the impact of crypto-assets on the entity s financial position and financial performance. While the IASB has not added crypto-assets to its standard-setting agenda at this stage, along with other standard setters, it is continuing to monitor the development of crypto-assets and their significance for IFRS reporters. Accounting by holders of crypto-assets August

4 1. Introduction Money has been used for centuries to facilitate the trade of goods and services. The form of money has varied between cultures, but, essentially, there are three types: commodity money; representative money; and fiat money. Commodity money has value in and of itself (intrinsic value) as well as value in its use as money (e.g., coins from precious metals, salt, tobacco, coffee and wheat). Representative money has little or no intrinsic value, but embodies a right to an underlying item of value (e.g., gold certificates and depository notes that may be swapped against a certain amount of gold or silver). Fiat money is declared to be money by a government and therefore derives value from being legal tender. 1 In more recent times, bitcoin was launched as a crypto-currency. Subsequently, numerous other cryptocurrencies, crypto-coins and crypto-tokens have been launched with varying purposes and levels of adoption. The European Central Bank (ECB) defines a virtual currency as a digital representation of value, not issued by a central bank, credit institution or e-money institution, which, in some circumstances, can be used as an alternative to money. 2 As crypto-assets are still evolving, this publication will simply refer to cryptoassets when discussing the various permutations of cryptocurrencies, cryptocoins and crypto-tokens. A previous EY publication, IFRS (#) Accounting for crypto-assets, provides more detail in defining crypto-assets and their various characteristics, features and permutations. 3 This publication aims to provide guidance on the accounting under IFRS 4 by the general holders of crypto-assets, but does not address the accounting for crypto-assets held by the original issuer. Moreover, the specific issues related to miners, crypto-exchanges and those resulting from initial coin offerings (ICOs) are not addressed here. At the time of writing, over 1,700 different cryptocurrencies, cryptocoins and crypto-tokens were traded or listed on various cryptoexchanges. 2. Overview of crypto-asset classification At the time of writing, more than 1,700 different cryptocurrencies, cryptocoins and crypto-tokens were traded or listed on various crypto-exchanges. 5 The terms and application of these crypto-assets vary widely and could change over time. It is important to re-evaluate the accounting as terms and conditions change. Some crypto-assets entitle the holder to an underlying good or service from an identifiable counterparty. For example, some crypto-assets entitle the holder to a fixed weight of gold from a custodian bank. In those cases, the holder is 1 What is money, European Central Bank website, accessed on 6 August Virtual currency schemes a further analysis, European Central Bank website, accessed on 6 August IFRS (#) Accounting for crypto-assets, available on 4 This publication only considers IFRS and is not intended for other accounting frameworks (e.g., US GAAP). 5 Crypto Currency Market Capitalisation, CoinMarketCap website, accessed 6 August Accounting by holders of crypto-assets August

5 able to obtain economic benefits by redeeming the crypto-asset for the underlying. While not money as such, these crypto-assets share many characteristics with representative money. Other crypto-assets (e.g., bitcoins) do not entitle the holder to an underlying good or service and have no identifiable counterparty. The holder of such a crypto-asset has to find a willing buyer that will accept the crypto-asset in exchange for cash, goods or services in order to realise the economic benefits from the crypto-asset. While an entity can directly hold its crypto-assets in its own wallet, it is also possible that an entity s crypto-assets are comingled in a joint or shared wallet. By directly holding a crypto-asset in its own wallet, the entity has legal ownership of the crypto-asset. However, where a custodian (e.g., a crypto-asset broker) holds an entity s crypto-assets, or where the exchange comingles crypto-assets into one or more shared wallets, the legal ownership could rest with another party. In that case, the holder would not have exclusive title to the crypto-assets and the accounting would depend on the rights and obligations associated with the manner in which the crypto-assets are held. For example, an entity holding an economic interest in crypto-assets in the shared wallet of a crypto-asset exchange may have an indirect holding of the crypto-assets through a claim on the exchange. In this case, in addition to the underlying crypto-asset volatility, the holder would also be exposed to counterparty performance risk (i.e., the possibility that the exchange is not holding sufficient crypto-assets to cover all customer claims). Furthermore, some exchanges may restrict the holder s ability to transfer the crypto-asset to another exchange or the holder s own crypto-asset wallet. These limitations could alter the rights of the holder as they could effectively limit the holder s control over the underlying crypto-assets and the crypto-assets potential to produce economic benefits. The holder would need to analyse carefully, among other things, its claim on the crypto-exchange in order to evaluate the nature of the assets held in order to determine the appropriate accounting treatment. This publication is written in the context of a direct holding of crypto-assets. However, many aspects of the discussion, especially those related to financial instruments (section 3.2), prepayments (section 3.4) and intangible assets (section 3.5), are also relevant for indirect holdings of crypto-assets. How we see it Crypto-assets often have very different terms and conditions. The holder needs to evaluate their individual terms and conditions carefully in order to determine which International Financial Reporting Standard (IFRS) applies. Depending on the standard that applies, the holder may also need to assess its business model in determining the appropriate accounting. Determining ownership of a crypto-asset when it is held by a custodian or a crypto-exchange may present additional challenges and could impact the determination of the appropriate accounting. Accounting by holders of crypto-assets August

6 The diagram below aims to provide an overview of the possible classifications under current IFRS that a holder of crypto-assets should consider. Each circle in the diagram corresponds to a section below that provides a detailed analysis of the relevant IFRS requirements and other considerations and is set out in the order in which we discuss the different possible accounting classifications. Overview of crypto-asset classification Accounting by holders of crypto-assets August

7 3. Classification and measurement Crypto-assets have diverse terms and conditions, and the purpose for holding them also differs among holders. Hence, holders of a crypto-asset will need to evaluate their own facts and circumstances in order to determine which accounting classification and measurement under current IFRS should be applied. Depending on the standard, the holder may also need to assess its business model in order to determine the appropriate classification and measurement. The sections below consider the definitions and other requirements for being within the scope of the various accounting standards that could apply to a crypto-asset held and the respective measurement requirements. An inherent characteristic of a crypto-asset is that it is a digital representation and, hence, intangible by nature. The following accounting standards only apply to tangible assets and, therefore, do not apply to crypto-assets: IAS 16 Property Plant and Equipment applies to tangible items 6 IAS 40 Investment Property applies to land, a building (or part thereof), or both 7 IAS 41 Agriculture applies to biological assets (i.e., living animals or plants) 8 In addition, IFRS 6 Exploration for and Evaluation of Mineral Resources applies to exploration and evaluation expenditures incurred in the search for mineral resources (minerals, oil, natural gas and similar non-regenerative resources). 9 Although some crypto-assets are created by a process called mining, IFRS 6 only applies to exploration and evaluation expenditure in connection with the search for mineral resources before extraction. Therefore, an entity should not apply IFRS 6 in accounting for crypto-assets. This leaves the following accounting treatments to be considered for cryptoassets Cash and cash equivalents (see 3.1 below) IFRS 9 Financial instruments (see 3.2 below) IAS 2 Inventories (see 3.3 below) Prepayment assets (see 3.4 below) IAS 38 Intangible Assets (see 3.5 below) Developing an accounting policy under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (see 3.6 below) We believe the overview in section 2 above provides a helpful roadmap for an entity to assess the classification, measurement, presentation and disclosure requirements related to crypto-assets. 6 IAS 16.6 Definitions 7 IAS 40.5 Definitions 8 IAS 41.5 Definitions 9 IFRS 6 Appendix A, Defined terms Accounting by holders of crypto-assets August

8 3.1 Cash and cash equivalents Cash IAS 7 Statement of Cash Flows defines cash as cash on hand and demand deposits, but IFRS does not define these terms in any further detail. The ECB, International Monetary Fund and US Federal Reserve note that money has three different functions, as follows: Medium of exchange Unit of account Store of value 10 IAS 32 Financial Instruments: Presentation uses cash and currency interchangeably. In practice, currency is synonymous with the money, both physical and electronic, in circulation in a particular jurisdiction. IAS 32 also notes that cash is a financial asset that represents the medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements. 11 Demand deposits generally represent deposits that can be withdrawn on demand, without prior notice or penalty. While a crypto-asset may be accepted as payment by certain entities within a jurisdiction, it does not automatically become legal tender in that jurisdiction. Cash, as currently presented in the financial statements, tends to be the physical holdings and demand deposits of fiat currencies issued, or supported, by the governments of various jurisdictions. Fiat currencies have little or no intrinsic value, but are generally accepted as a medium of exchange in a jurisdiction because they are supported by government and recognised as legal tender in their respective jurisdictions. Legal tender status is conferred by law in a jurisdiction and is typically reserved for notes and coins issued by a central bank or an organisation authorised by the government. According to the Bank of England, legal tender has a very narrow and technical meaning: the debtor cannot be sued for non-payment if the debtor offers full payment of his or her debt in legal tender. 12 In addition, what is classified as legal tender is typically a matter of law in the specific jurisdiction. Therefore, while a crypto-asset may be accepted for payment by certain entities within a jurisdiction, it does not automatically become legal tender in that jurisdiction. IAS 32 indicates that cash is the basis on which all transactions are measured and recognised in the financial statements. Currently, it is unlikely that a cryptoasset would be considered a suitable basis for measuring and recognising items in an entity s financial statements. 10 What is money, European Central Bank website, accessed on 6 August The International Use of Currencies: The U.S. Dollar and the Euro, International Monetary Fund website, accessed on 6 August The Location of U.S. Currency: How Much Is Abroad?, The Federal Reserve System website, accessed on 6 August IAS 32.AG3 12 What is legal tender? The Bank of England KnowledgeBank website, accessed on 6 August Accounting by holders of crypto-assets August

9 How we see it While it is necessary for a crypto-asset to be legal tender before it can potentially be considered cash, the legal tender status by itself may not be sufficient. A holder needs to consider other factors such as whether the crypto-asset represents a medium of exchange and the basis on which the holder recognises and measures all transactions in its financial statements. While some governments are reported to be considering issuing their own crypto-assets or supporting a crypto-asset issued by another party, it is unclear at this stage whether those crypto-assets would be legal tender (i.e., they must be accepted as payment for legal extinguishment of a pre-existing debt). Private issuers of crypto-assets lack the authority to confer legal tender status. Therefore, even if those crypto-assets are used or accepted as a means of payment, they are not considered cash for the purposes of IFRS. To some extent, these crypto-assets are similar to privately issued gift cards which, even if they are accepted by a wide range of merchants, are not considered cash either Cash equivalents IAS 7 defines cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. IAS 7 goes on to indicate that cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes and that an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Cash equivalents is a presentational category and does not dictate the recognition or measurement of the asset. Therefore, a crypto-asset would need to be classified and measured under the applicable accounting standard before it could be considered as a cash equivalent for presentation purposes. The IFRS Interpretations Committee (formerly the International Financial Reporting Interpretations Committee) confirmed, in 2009, 13 that the amount of cash that will be received must be known at the time of the initial investment in order for an instrument to meet the definition of cash equivalents. Accordingly, crypto-assets cannot be considered cash equivalents unless they are held for meeting short-term cash commitments, have a short maturity, are subject to an insignificant risk in change of value, and the amount of cash that will be received on maturity is already known when the crypto-asset is initially acquired. How we see it Crypto-assets currently do not meet the definition of cash equivalents because they are generally, among others, not convertible to known amounts of cash, nor are they subject to an insignificant risk of change in value. 13 IFRIC Update July 2009 IASB website, Updates/2009/Documents/IFRIC0905.pdf, accessed on 6 August Accounting by holders of crypto-assets August

10 3.2 Financial instruments IAS 32 defines a financial instrument as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity Contractual right The first part of the definition of a financial instrument requires the existence of a contract or contractual relationship between parties. This is emphasised in the application guidance of IAS 32, which notes assets or liabilities that originate from statutory requirements (e.g., income taxes) are not financial instruments. Similarly, whilst highly liquid, gold bullion is not a financial instrument as it does not convey a contractual right to receive cash or another financial asset. A contract is defined by IAS 32 as an agreement between two or more parties that has clear economic consequences which the parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law. 14 Contracts may take a variety of forms and need not be in writing. Crypto-assets, that are not contractual themselves, could still be the subject of a contract between parties entered into off the chain. The use of blockchain or distributed ledger technology does not automatically give rise to a contractual relationship between parties. On the one hand, crypto-assets that entitle the holder to underlying goods, services or financial instruments provided by an identifiable counterparty could meet the definition of a contract. On the other hand, crypto-assets that do not entitle the holder to underlying goods, services or financial instruments and have no identifiable counterparty would not meet the definition of a contract. For example, the individual parties involved in the bitcoin blockchain do not have a contractual relationship with any other participant in the bitcoin blockchain. That is, by virtue of owning a bitcoin, the holder does not have an enforceable claim on bitcoin miners, exchanges, holders or any other party. Such holders need to find a willing buyer in order to realise economic benefits from holding their bitcoin. Crypto-assets that are not contractual themselves could still be the subject of a contract, for example, a binding agreement to buy bitcoins from a certain counterparty would constitute a contract, even though the bitcoin itself does not represent a contractual relationship. Therefore, agreements entered into off the chain to buy or sell crypto-assets could be contracts as defined above. How we see it Holders of crypto-assets need to consider carefully whether the terms and conditions of their crypto-assets give rise to a contract. In the absence of a contract, a crypto-asset is not a financial instrument Financial asset or prepayment? The second part of the definition of a financial instrument requires that a financial instrument gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. So in order to be a financial instrument, a crypto-asset will need to represent a financial asset for the holder. 14 IAS Accounting by holders of crypto-assets August

11 IAS 32 defines a financial asset as any asset that is: Cash; An equity instrument of another entity; A contractual right: To receive cash or another financial asset from another entity; or To exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or A contract that will or may be settled in the entity s own equity instruments and certain other criteria are met. 15 In the context of crypto-assets, a financial asset could be: cash (see 3.1 above), an equity instrument of another entity, a contractual right to cash or other financial assets, or a right to trade financial instruments on potentially favourable terms (e.g., a derivative). The sections below analyse whether a crypto-asset might meet the definition of a financial asset, other than cash, by considering each of these options in turn. Crypto-assets that entitle the holder to underlying goods or services provided by an identifiable counterparty, despite being contractual, would not meet the definition of financial assets as the future economic benefit is obtained from the receipt of a good or services rather than the right to cash or another financial asset. 16 For example, a crypto-asset that entitles the holder to cloud computing services, even if contractual, would not be a financial asset as the future benefit is a service rather than the right to a financial asset. Holders of such crypto-assets should evaluate the appropriate accounting based on the relevant IFRS standard. The discussion related to prepayments (section 3.4 below) and intangible assets (section 3.5 below) could also be relevant. Whether a contractual right exists for the holder of the crypto-asset to receive underlying goods and services may require a careful examination of the specific facts and circumstances and the enforceability of the contract. Although the value of a crypto-asset may correlate to the popularity of an underlying platform on which it is used, that, by itself, does not represent a contractual right to a residual interest in the net assets of the platform Equity instrument IFRS defines an equity instrument as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Hence, a crypto-asset that conveys such rights would, in substance, be an electronic share certificate and as a result a financial asset. Even if a crypto-asset gave rise to a variable stream of cash flows, that would not automatically mean that it met the definition of an equity instrument. For example, a crypto-asset that entitles the holder to a share of the gross royalty stream on an intangible asset (e.g., an online game) would not be an equity instrument. Additionally, a constructive obligation on the part of the issuer of a crypto-asset does not give rise to a contractual right to a residual interest that qualifies as an equity instrument for the holder. Finally, although the value of a crypto-asset may be correlated to the popularity of an underlying platform on which it is used, that by itself does not represent a contractual right to 15 Refer to IAS 32.11(d) for further details. 16 IAS 32.AG11 Accounting by holders of crypto-assets August

12 a residual interest in the net assets of the underlying platform (i.e., it is not an equity instrument). How we see it A crypto-asset is only an equity instrument under IFRS if it embodies a contractual right to a residual interest in the net assets of a particular entity. Equity instruments held are initially recorded at fair value, without adjusting for transaction fees, and, subsequently, measured as at fair value through profit or loss under IFRS 9. However, the holder of equity instruments that also meet the definition of equity from the perspective of the issue, but are not held for trading, may make an irrevocable election, on initial recognition, to present subsequent fair value changes in other comprehensive income, without recycling. In such a case, the fair value on initial recognition is adjusted for attributable transaction fees Contractual right to cash or another financial asset A crypto-asset, that is not an equity instrument (see above) or a derivative (see below) would still meet the definition of a financial asset if it is both contractual and embodies a right to receive cash or another financial asset. For example, a crypto-asset that entitles the holder to a cash payment, or the delivery of bonds or shares would meet the definition of a financial asset. In such cases, the crypto-asset would, in effect, be akin to a digital deposit slip, which exposes the holder to the economic risk on the underlying financial asset as well as counterparty risk. Such a crypto-asset will be subject to the IFRS 9 classification and measurement requirements. All financial assets are initially recorded at fair value plus attributable transaction costs, apart from those subsequently measured at fair value through profit or loss, in which case, the transaction costs should be expensed as incurred. Subsequent measurement depends on the cash flow characteristics of the asset and the business model in which it is held. Financial assets, aside from equity instruments (discussed at above), which fail the solely payment of principal and interest (SPPI) cash flow characteristics test, as well as those held for trading, are measured at fair value through profit or loss. The business model in which they are held drives the measurement of financial assets that do meet the SPPI test. Those in a held to collect business model are measured at amortised cost under IFRS 9. While those in a held to collect and sell business model are measured at fair value through other comprehensive income, with subsequent recycling to profit or loss on derecognition. IFRS 9, however, allows a holder to designate a financial asset, despite meeting the SPPI cash flow characteristics test, as at fair value through profit or loss, on initial recognition, if doing so reduces or eliminates an accounting mismatch Derivative IFRS 9 defines a derivative as a financial instrument or other contract within the scope of IFRS 9 with all three of the following characteristics: 17 This election is not available for contingent consideration recognised by an acquirer in a business combination under IFRS 3 Business Combinations. Accounting by holders of crypto-assets August

13 Its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided that, in the case of a non-financial variable, the variable is not specific to a party to the contract (sometimes called the underlying ) It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors It is settled at a future date Therefore, a derivative can originate from either a financial instrument or another contract, provided that contract is in the scope of IFRS 9. These other contracts are discussed below. Some contractual rights to buy or sell non-financial items that can be settled net in cash, or for which the non-financial items are readily convertible to cash, are accounted for as if they were financial instruments (i.e., a derivative). This does not apply to own-use 18 contracts, unless these are designated as at fair value through profit or loss on initial recognition in accordance with paragraph 2.5 of IFRS 9. The holder of such a right should consider whether it meets all three of the characteristics of a derivative, discussed above, and, if so, account for that right as a derivative. A contractual right to buy or sell crypto-assets (e.g., a bitcoin forward entered into with an investment bank) could be a derivative even if the crypto-asset itself is not a financial instrument, provided the crypto-asset is readily convertible to cash or the contract can be settled net in cash. This is similar to the accounting for commodity contracts that are held in a trading business model (e.g., forward oil contracts may fall within the scope of IFRS 9, although oil itself is not a financial instrument). Measurement Derivatives are initially recorded at fair value and subsequently measured at fair value through profit or loss, without any deduction for sale or disposal costs. However, for a derivative designated as a hedging instrument in a cash flow hedge, the fair value movements relating to the effective hedge portion are recorded in other comprehensive income until the hedged item affects profit or loss. How we see it An entity will need to evaluate a contractual right to buy or sell cryptoassets that can be settled net or where the underlying crypto-asset is readily convertible into cash, to determine whether the contract is within the scope of IFRS 9 and, therefore, should be accounted for as a derivative. However, a gross-settled contract to buy or sell a non-financial crypto-asset, which is not traded in an active market, would not be in the scope of IFRS 9 as the crypto-asset would not be readily convertible into cash. 18 This refers to those contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity s expected purchase, sale or usage requirements as discussed in IFRS Accounting by holders of crypto-assets August

14 3.3 Inventory Although this is often assumed, IAS 2 does not require inventory to be tangible. The standard defines inventory as an asset: Held for sale in the ordinary course of business; In the process of production for such sale; or In the form of materials or supplies to be consumed in the production process or in the rendering of services. Crypto-assets could be held for sale in the ordinary course of business, for example, by a commodity broker-trader. Whether crypto-assets are held for sale in the ordinary course of business would depend on the specific facts and circumstances of the holder. In practice, crypto-assets are generally not used in the production of inventory and, thus, would not be considered materials and supplies to be consumed in the production process. IAS 2 does not apply to financial instruments (see section 3.2). Thus, where a crypto-asset meets the definition of a financial instrument, it should be accounted for as such under IFRS 9 rather than as inventory under IAS 2. Normally, IAS 2 requires measurement at the lower of cost and net realisable value. However, commodity broker-traders who acquire and sell crypto-assets principally to generate profit from fluctuations in price or broker-traders margin have the choice to measure their crypto-asset inventories at fair value less costs to sell Cost or lower net realisable value The costs of purchased crypto-asset inventories would typically comprise the purchase price, irrecoverable taxes and other costs directly attributable to the acquisition of the inventory (e.g., blockchain processing fees). Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the crypto-asset inventories to their present location and condition. The cost of inventory excludes anticipated selling costs as well as storage expenses (e.g., costs of holding a wallet or other crypto-account), unless storage between production stages is necessary in the production process, which is unlikely to apply to crypto-assets. Net realisable value is defined in IAS 2 as the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost necessary to make the sale. The cost of crypto-assets recorded as inventory may not be recoverable if those crypto-assets have become wholly or partially obsolete (due to a declining interest in the crypto-asset or its application) or if their selling prices have declined. Similarly, the cost of crypto-asset inventory may not be fully recoverable if the estimated costs to sell them have increased. An entity holding crypto-asset inventory will need to estimate the net realisable value at each reporting period. Where this is below cost, the inventory should be written down to its net realisable value with the write-down being recorded in profit or loss. A previous write-down of inventory is reversed when circumstances have improved, but the reversal is limited to the amount previously written down so that the carrying amount never exceeds the original cost. Accounting by holders of crypto-assets August

15 How we see it Estimating the selling costs for crypto-assets classified as inventory may present challenges for a holder as these selling costs can fluctuate significantly depending on the current demand for processing on the particular blockchain. This can be illustrated by reference to the bitcoin blockchain, where the average transaction fee in December 2017 was above US$ 55 compared with an average of just below US$ 2 at the time of writing. A broker-trader that measures its inventory at fair value less costs to sell should include any changes in the recognised amount in profit or loss for the period Fair value less costs to sell As noted above, commodity broker-traders may also measure their commodity inventories at fair value less costs to sell. Broker-traders are those who buy or sell commodities for others or on their own account. When these commodities are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders margin, they can be classified as commodity inventory at fair value less costs to sell. When a broker-trader measures its inventory at fair value less costs to sell, any changes in the recognised amount should be included in profit or loss for the period. 19 A broker-trader holder of a crypto-asset will need to estimate the costs to sell the crypto-asset at each reporting date, taking into consideration the transaction cost on the relevant blockchain and other fees required in order to convert the crypto-asset into cash. These fees could fluctuate significantly from period to period, depending on the current demand for processing on the relevant blockchain. DigitalX Limited, in its consolidated financial statements for the year ended 30 June 2017, explained why it is considered to be a broker-trader of bitcoins which are held at fair value less costs to sell. Extract from DigitalX Limited s 2017 annual report NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Extract) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Extract) 2.13 Bitcoin inventory (Extract) Bitcoin is an open-source software-based online payment system where payments are recorded in a public ledger using its own unit of account called a bitcoin. The Group is a broker-trader of bitcoin as it buys and sells bitcoins principally for the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders margin. The Group measures bitcoin inventory at its fair value less costs to sell, with any change in fair value less costs to sell being recognised in profit or loss in the period of the change. Bitcoins are derecognised when the Group has transferred substantially all the risks and rewards of ownership. 19 IAS 2.3(b) Accounting by holders of crypto-assets August

16 3.4 Prepayments A prepayment is an asset recorded where an entity has paid for goods or services before delivery of those goods or services. 20 As prepayments entitle an entity to future goods or services rather than a right to cash, financial assets or a right to trade financial instruments on favourable terms, they are not financial assets. However, where a crypto-asset entitles the holder to buy or sell an underlying asset that is readily convertible to cash, the derivative guidance (section above) could be relevant. A crypto-asset that entitles the holder to a future good is more akin to an electronic voucher. An entity s intention, and business model, would be relevant in determining the appropriate accounting for such a voucher. If the entity does not intend to hold on to the crypto-asset in order to take delivery of the underlying good, accounting for it as a prepayment would generally not be appropriate and the intangible asset guidance (section 3.5 below) should be considered. Measurement There is very limited guidance in IFRS on accounting for prepayments. In practice, prepayments are often recognised at cost and are subject to impairment testing under IAS 36 Impairment of Assets. Given the limited guidance in IFRS, an entity will need to develop an accounting policy and apply it consistently to similar items and across reporting periods (see section 3.6). How we see it If the only feasible way of realising the economic benefits of a crypto-asset is by accepting subsequent delivery of the underlying goods or services, the holder could account for it as a prepayment. However, if the holder could also realise economic benefits by trading the crypto-asset, the holder should evaluate its business model. If an entity intends to trade the crypto-asset, it would generally not be appropriate to account for it as a prepayment. 3.5 Intangible assets IAS 38 defines an asset as a resource controlled by an entity as a result of past events; and from which future economic benefits are expected to flow to the entity. Intangible assets form a sub-section of this group and are further defined as an identifiable non-monetary asset without physical substance. 21 A monetary asset is either money held or an asset to be received in fixed, or determinable, amounts of money. A crypto-asset that does not meet the definition of cash or a financial instrument would generally be a non-monetary asset Definition of intangible asset The IASB considers that the essential characteristics of intangible assets are that they: Are controlled by the entity 20 IAS IAS 38.8 Definitions Accounting by holders of crypto-assets August

17 Will give rise to future economic benefits for the entity Lack physical substance Are identifiable An item with these characteristics is classified as an intangible asset regardless of the reason why an entity holds that asset. 22 Control Control is the power to obtain the future economic benefits of an item while restricting the access of others to those benefits. Control is normally evidenced by legal rights, but IAS 38 is clear that they are not required where the entity is able to control access to the economic benefits in another way. IAS 38 notes that, in the absence of legal rights, the existence of exchange transactions for similar non-contractual items can provide evidence that the entity is nonetheless able to control the future economic benefits expected. 23 Future economic benefits Many crypto-assets do not provide a contractual right to economic benefits. Instead, economic benefits are likely to result from a future sale, to a willing buyer, or by exchanging the crypto-asset for goods or services. Lacks physical substance As crypto-assets are digital representations, they are by nature without physical substance. Identifiable In order to be identifiable, an intangible asset needs to be separable (capable of being sold or transferred separately from the holder) or result from contractual or other legal rights. As most crypto-assets can be freely transferred to a willing buyer, they would generally be considered separable. Similarly, crypto-assets that result from contractual rights would generally be considered separable. How we see it Crypto-assets generally meet the relatively wide definition of an intangible asset, as they are identifiable, lack physical substance, are controlled by the holder and give rise to future economic benefits for the holder. Intangible assets should be accounted for under IAS 38, except when they are within the scope of another standard Scope of IAS 38 Intangible assets should be accounted for under IAS 38, except when they are within the scope of another standard (e.g., crypto-assets that meet the definition of a financial asset under IAS 32 or crypto-assets held for sale in the ordinary course of business under IAS 2). The accounting for crypto-assets outside the scope of IAS 38 is discussed in sections 3.1 to 3.4 above. IAS 38 notes that exclusions from its scope may occur if activities or transactions are so specialised that they give rise to accounting issues that may need to be dealt with in a different way. The standard goes on to state that it does not apply to the accounting for expenditure on the exploration for, or development and extraction of, oil, gas and mineral deposits in extractive industries and the accounting for insurance contracts. 22 IAS 38.BC5 23 IAS Accounting by holders of crypto-assets August

18 However, this exclusion is generally restricted to extractive activities and insurance contracts. Therefore, without further standard setter guidance, a holder should not assume these specific exclusions extend to crypto-assets Recognition requirements An intangible asset is only recognised if it is probable that future economic benefits will flow to the entity and its cost can be measured reliably. Separately acquired intangible assets will normally be recognised as IAS 38 assumes that the acquisition price reflects the expectation of future economic benefits. Thus, an entity always expects future economic benefits, for these intangibles, even if there is uncertainty about the timing or amount Initial measurement Intangible assets are initially measured at cost. The cost of acquiring cryptoassets would typically include the purchase price (after deducting trade discounts and rebates, if any) and the related transaction costs, which could include blockchain processing fees. Where an intangible asset is acquired in exchange for another non-monetary asset, the cost is measured at fair value, unless the transaction lacks commercial substance or the fair value of neither the asset acquired nor the asset given up can be measured reliably. In such instances, the cost of the intangible asset is measured as the carrying amount of the asset given up Subsequent measurement requirements There are two subsequent measurement approaches under IAS 38 that can be applied as an accounting policy choice to each class of intangible asset, namely: Cost model Revaluation model (subject to criteria as discussed below) An entity that holds different types of crypto-assets would need to assess whether they constitute different classes of intangible assets as the rights and underlying economics of different crypto-assets vary widely Cost model The cost method under IAS 38 entails subsequent measurement at cost less any amortisation and impairment. Useful life and amortisation Many crypto-assets such as bitcoins do not have an expiry date, and there appears to be no foreseeable limit to the period over which they could be exchanged with a willing counterparty for cash or other goods or services. A holder will therefore need to consider if there is a foreseeable limit to the period over which such a crypto-asset is expected to generate net cash inflows for the entity. If there is no foreseeable limit, such a crypto-asset could be considered to have an indefinite 24 useful life and, as a result, no amortisation is required. However, indefinite useful life intangible assets need to be tested for impairment at least annually and whenever there is an indication of impairment. Where there is a foreseeable limit to the period over which a crypto-asset is expected to generate net cash inflows for the holder, a useful life should be 24 Not to be confused with an infinite useful life (IAS 38.91). Accounting by holders of crypto-assets August

19 estimated and the cost of the crypto-asset, less any residual value, should be amortised on a systematic basis over this useful life. In addition, such a cryptoasset is also subject to IAS 36 impairment testing whenever there is an indication of impairment. There are no provisions in IAS 38 that allow for the fair value of an intangible asset to be determined indirectly. If no Level 1 price exists, the holder will need to apply the cost method to the crypto-asset held. Impairment and impairment reversal When impairment testing determines that an intangible asset is impaired, the holder is required to write down the carrying amount of the intangible asset to its recoverable amount and to record the write-down in profit or loss for the period. In later periods, the holder would need to evaluate whether there is an indication that an impairment loss may no longer exist (or that the loss may have decreased) and if so, determine the recoverable amount. IAS 36 allows the holder to record an impairment reversal provided the updated carrying amount does not exceed the asset s original cost less the amortisation that would have been recorded had no previous impairment been recognised Revaluation model An entity can only apply the revaluation model if the fair value can be determined by reference to an active market, which is defined by IFRS 13 Fair Value Measurement as a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. There are no provisions in IAS 38 that allow for the fair value of an intangible asset to be determined indirectly, 25 for example, by using valuation techniques and financial models such as those applied to estimate the fair value of intangible assets acquired in a business combination. Consequently, if no observable price in an active market for an identical asset exists (i.e., a Level 1 price under IFRS 13), the holder will need to apply the cost method to crypto-assets held. How we see it In assessing whether an active market exists for a crypto-asset, the holder will need to consider whether there is economic substance to the observable transactions, as many trades on crypto-exchanges are non-cash transactions in which one crypto-asset is exchanged for another and the holder may find it difficult to convert the crypto-asset into cash. Under the revaluation model, intangible assets are measured at their fair value on the date of revaluation less any subsequent amortisation and impairment losses. The net increase in fair value over the initial cost of the intangible asset is recorded in the revaluation reserve via other comprehensive income. A net decrease below cost is recorded in profit or loss. The cumulative revaluation reserve may be transferred directly to retained earnings upon derecognition, and possibly by transferring the additional amortisation on the revalued amount to retained earnings as the asset is used, but IAS 38 does not allow the revaluation reserve to be transferred via profit or loss. 25 IAS and IAS Accounting by holders of crypto-assets August

20 3.6 Own accounting policy IAS 8 requires that when an IFRS specifically applies to a transaction, other event or condition, the accounting policy applied to that item should be determined by applying that IFRS and considering any relevant implementation guidance issued by the IASB. 26 For example, if a crypto-asset has been appropriately assessed to be an intangible asset subject to IAS 38, the holder is required to apply IAS 38 in accounting for that crypto-asset. In such cases, it would generally not be appropriate to analogise to another standard such as IAS 40 or the financial instruments literature under IFRS 9. However, in the absence of a standard that specifically applies to a transaction, event or condition, the accounting hierarchy in IAS 8 allows an entity to use its judgement in developing an accounting policy that results in information that is: Relevant to the economic decision-making needs of users Reliable, in that the financial statements: Represent faithfully the financial position, financial performance and cash flows of the entity Reflect the economic substance of transactions, other events and conditions, and not merely the legal form Are neutral, i.e., free from bias Are prudent Are complete in all material respects 27 In making this judgement, management is required to consider the following sources in descending order: The requirements and guidance in IFRS dealing with similar and related issues The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Conceptual Framework for Financial Reporting within IFRS 28 Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources above. 29 How we see it Where no other standard applies and an entity develops its own accounting policy for a crypto-asset held under the IAS 8 hierarchy, the entity needs to consider if the guidance in IFRS dealing with similar and related issues and the relevant definitions and recognition criteria in the Conceptual Framework would preclude it from being recognised as an asset. In that case, the cost incurred in obtaining the crypto-asset should be expensed as incurred. 26 IAS IAS IAS IAS 8.12 Accounting by holders of crypto-assets August